Definition
A Potentially Exempt Transfer (PET) is a gift made during your lifetime to another person that becomes completely exempt from Inheritance Tax if you survive for seven years after making it.
The term "potentially" is crucial—your gift isn't automatically tax-free but conditional on your survival. This makes PETs one of the most important tools for reducing Inheritance Tax liability through lifetime gifting.
What Does Potentially Exempt Transfer Mean?
When you give money or assets to another person during your lifetime, you're making what tax law calls a Potentially Exempt Transfer under the Inheritance Tax Act 1984, Section 3A. The legislation uses the word "potentially" because exemption depends entirely on one critical factor: whether you survive for at least seven years after making the gift. Most gifts between individuals are PETs—this is the default position for lifetime gifts, not an exceptional planning tool. There's no immediate Inheritance Tax liability when you make the gift, and no requirement to report it to HMRC at the time.
If you survive seven or more years after making the gift, it becomes fully exempt and is removed from your estate entirely for Inheritance Tax purposes. However, if you die within seven years, the gift becomes what's known as a "failed PET" or chargeable transfer. The gift's value is then added back to your estate, and Inheritance Tax may be payable depending on the total value and your available nil-rate band (currently £325,000). The recipient is primarily liable for any Inheritance Tax due on a failed PET, though estates sometimes pay this from remaining funds. Sarah gives her daughter £200,000 in 2020 to help buy a house. When Sarah dies in 2029—nine years later—the gift is completely exempt from Inheritance Tax and doesn't form part of Sarah's estate.
Taper relief can reduce tax on failed PETs if death occurs between three and seven years after the gift, but this only applies to the portion exceeding the nil-rate band. James gifts £400,000 to his son in January 2023 but dies in December 2024, less than two years later. The first £325,000 is covered by the nil-rate band (assuming no other gifts), but the remaining £75,000 is subject to 40% Inheritance Tax, creating a £30,000 tax bill. If Emma gifts £500,000 in 2020 and dies in 2025 (five years later), taper relief at 40% applies to the £175,000 exceeding the nil-rate band, reducing the tax from £70,000 to £42,000. You can make unlimited PETs—there's no maximum value or annual limit on the number of gifts.
Not all lifetime gifts qualify as PETs. Only outright gifts directly to individuals are PETs—gifts to most types of trusts are Chargeable Lifetime Transfers (CLTs), which face immediate tax charges on amounts over £325,000. Additionally, you must completely relinquish all benefit from the gifted asset. If Robert transfers his £600,000 house to his daughter but continues living there rent-free, this is a "gift with reservation of benefit" and remains in his estate regardless of how long he survives. To qualify as a valid PET, Robert would need to either pay market rent or move out entirely. Multiple PETs are cumulative and use up your nil-rate band chronologically—the oldest gifts use it first. Limited exceptions exist: gifts to disabled trusts and bereaved minors' trusts can qualify as PETs despite being trusts.
Common Questions
"I want to give my daughter £150,000 to help her buy a house. Will she have to pay tax on this gift?"
No immediate tax is due when you make the gift—this is a Potentially Exempt Transfer. If you survive for seven years after making the gift, it becomes completely tax-free. If you die within seven years, it may be subject to Inheritance Tax depending on the total value of your estate and other gifts you've made.
"I've been giving my children money every year for the past five years—around £50,000 each time. Do all these gifts count if I die soon?"
Yes. Each gift over £3,000 per year is a Potentially Exempt Transfer, and all PETs made in the seven years before death are added back to your estate for Inheritance Tax calculation. The oldest gifts use your nil-rate band first, so gifts made more than seven years ago are completely exempt and don't count.
"I'm 65 and want to reduce my Inheritance Tax bill. If I give away money now, how long do I have to live for it to be tax-free?"
You need to survive for seven full years after making the gift for it to become completely exempt from Inheritance Tax. If you die between three and seven years after the gift, taper relief may reduce the tax charged (but not eliminate it). Gifts made within three years of death receive no taper relief.
Common Misconceptions
Myth: If I survive three years after making a gift, most of the tax is reduced
Reality: Taper relief only reduces the amount of tax charged on the portion of a failed PET that exceeds the nil-rate band—it doesn't reduce the value of the gift itself. For many estates, if the total estate plus failed PETs is under £325,000, taper relief provides no benefit at all. You must survive the full seven years for the gift to be completely exempt.
Myth: All gifts to family members are Potentially Exempt Transfers
Reality: Only gifts directly to individuals are PETs. If you gift money into most types of trusts (even for your children or grandchildren), it's usually a Chargeable Lifetime Transfer, which is subject to an immediate 20% tax charge on amounts over £325,000. Additionally, if you give away an asset but continue to benefit from it (like giving your house to your children but living in it rent-free), it's not a PET at all—it's a "gift with reservation of benefit" and remains in your estate.
Related Terms
Understanding Potentially Exempt Transfers connects to these related concepts:
- Seven-Year Rule: Defines the core timing requirement that determines whether a PET becomes exempt or chargeable.
- Inheritance Tax: The tax that PETs are specifically designed to reduce through lifetime gifting strategies.
- Taper Relief: Reduces (but doesn't eliminate) Inheritance Tax on failed PETs when death occurs between 3-7 years after the gift.
- Chargeable Lifetime Transfer: The contrasting type of lifetime gift, typically to trusts, which is immediately taxable rather than potentially exempt.
- Lifetime Gift: The broader category encompassing both PETs and CLTs—any gift made during the donor's lifetime.
Related Articles
- Estate Planning Fundamentals: Establishes how PETs fit into your overall estate planning strategy as a critical tool for tax-efficient wealth transfer.
- Inheritance Tax Planning Strategies: Provides detailed guidance on using PETs effectively as part of a comprehensive Inheritance Tax reduction strategy.
- Tax-Efficient Gifting Strategies: Positions PETs alongside other gifting methods like annual exemptions and gifts from income to help you choose the most appropriate approach.
- Mid-Career Wealth Building: Demonstrates how early gifting using PETs can be incorporated into long-term financial planning while you're building wealth.
- Later-Life Estate Planning: Addresses practical considerations of making PETs in retirement, balancing Inheritance Tax savings against retaining sufficient assets for living expenses.
Need Help with Your Will?
Understanding Potentially Exempt Transfers is essential for effective estate planning, especially when your estate may exceed the £325,000 nil-rate band. Planning lifetime gifts strategically can significantly reduce the Inheritance Tax burden on your family while helping loved ones when they need support most.
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Legal Disclaimer: This glossary entry provides general information about UK legal terminology and does not constitute legal advice. For advice specific to your situation, consult a qualified solicitor.